Nama set to shift wealth to lenders and developers

OPINION:Forty-six academic economists and lecturers in business think the Government has got it wrong on the National Asset Management Agency. Here, they explain why

SINCE THE publication of the draft heads of the National Asset Management Agency (Nama) Bill some issues relating to how it will work have become clearer, while others remain less so.

Three main elements have attracted commentary. The first is the perceived lack of transparency concerning Nama’s operation and oversight by the Oireachtas of the agency’s actions. To be fair, Minister for Finance Brian Lenihan has stated that he is willing to take amendments, and in particular on this area.

Another issue, which remains opaque, is the duration and scope of Nama. In terms of duration we remain unclear as to how long it will linger. Minister for Defence Willie O’Dea has suggested that Nama could dispose of its task in seven to 10 years.

However, other sources have stated that it will not be bound to any time-frame, but will take as long as required.

This is bound up with the third element, the most opaque of all – the price that Nama will pay (in aggregate) for its assets.

The price and duration are interlinked as Nama will not necessarily pay market (or as they are now being called “fire clearance”) prices for land and development (as explained in section 58 of the Bill). Instead, it will, in the memorable phrase of Dr Peter Bacon, “mark to hope”.

This it will do by taking the market price as a basis and then adjusting upwards to “fair economic value”. This concept works on the assumption that in the short term, property and development prices will rise. Thus, Nama will make a profit and it would be somehow unfair to now pay a low asset price.

This has been criticised as flying in the face of evidence from previous similar crashes, and as being based on a very optimistic forecast of the Irish economy in the medium term.

The key difficulty facing the Government is that to pay existing market prices would leave the banks sitting on losses large enough as to effectively bankrupt them. This would then require the State to invest in the banks to such an extent as to effectively nationalise them.

Consequently, it is clear that the Government is determined to pay a price for land and speculative developments greatly in excess of the market clearing price.

Nama has unfolded against the slow but steady deterioration in the State’s finances. We now look to be on course for a Government deficit of close to €30 billion. In short, this means that for every €1 the State spends, it takes in tax only 50 cent.

To close this gap in State expenditure would require the implementation of more then five times the identified savings of the McCarthy report.

It is also clear that while world economic conditions might well begin to improve in 2010, this will not easily translate into improved conditions here. A significant structural deficit remains in place in the Irish State finances with as yet little in the way of solid policies implemented to close this.

Nama is expected to transfer about €90 billion (in book value) of loans from the banks. In exchange, the banks will receive a percentage of this value in the form of Nama bonds which can then be exchanged for cash at the European Central Bank.

While the precise national accounting treatment of these bonds remains unclear, it is prudent and correct to treat them as State liabilities for whose repayment the taxpayer will ultimately be responsible.

It is also highly probable that the agency cannot “pay for itself”. The loans being transferred are impaired, and by definition not paying their way. Even with the contribution of added value from performing loans, it remains probable that Nama will run at a loss. Consequently, the taxpayer will face an annual bill.

Regardless of this, and as noted, it is clear that the Government will pay significantly above market value for these loans. Current estimates are that the State may issue agency bonds worth upwards of €60 billion in total for the €90 billion book value.

However, judgments from court cases reveal that bond buybacks and debt for equity swaps in the majority of cases is not two-thirds of the book value, as would be implied by the Nama payment of €60 billion, but is closer to €30 billion.

Thus, by overpaying, the State will wind up transferring to private individuals a sum close to the entire tax take across all tax heads.

In a period of fiscal collapse this is surely not a decision that should be taken lightly, if at all.

At the conclusion of Nama or any alterative approach, all are agreed that what is required is a working, healthy, banking system.

All are agreed that Nama on its own is but an enabler of that. A healthy working banking system is not dependent, we suggest, on a massive transfer of wealth from taxpayers to private risk-takers.

A number of proposals have been put forward which would avoid this in whole or in part and which would, we argue, be at least as effective as Nama in laying the ground for such a banking system. These models have been well discussed through a variety of blogs on the web and in the mainstream media.

All share a number of key characteristics.

First, they work from the premise that those that have invested in risky capital in the banks (the shareholders and bondholders) must accept that the value of their asset is gravely impaired. At a minimum the equity element of the Irish banks, were they required to take on any significant part of the losses made in speculative lending, would be wiped out.

Second, they propose that certain classes of bondholders also be required to accept reductions in value. It is probable that the losses of the banks are such that even eliminating all equity value would not absorb said losses. Unlike the equity, most of the bonds are in great part covered by the 2008 State guarantee. However, the vast majority of this debt matures outside the September 2010 expiry date for this guarantee.

So the Government is in a strong position, if it chooses, to negotiate with bondholders to engage in some debt for equity swaps.

This on its own, however, is still unlikely to provide sufficient capital for the banks to operate without State support in an international environment that now demands far higher levels of capital than prevailed prior to the crisis.

Consequently the third element is that the State, on a temporary basis, becomes the pre-eminent shareholder in the banks, working swiftly to float a reorganised banking system anew. Alternative proposals have different “twists” to them. But the essence is that all three contain the three points mentioned above. Thus, to say that there is no alternative to Nama is incorrect.

We therefore urge the Government to reconsider its approach to payment for loans to be taken into Nama, to pay no more than current market value – which can be ascertained even in these times – and to require the investors in the banks to bear some of the cost of restructuring the system. Moreover, we also argue that the Government should not burden the State with more debt than is absolutely required.

To do otherwise would be economic folly.

LIST OF SIGNATORIES

Prof Brian Lucey, School of Business, Trinity College Dublin.

Prof Karl Whelan, Department of Economics, University College Dublin.

Prof Bernadette Andreosso-O’Callaghan, Department of Economics, Kemmy School of Business, University of Limerick.

Prof Colm Harmon, Department of Economics, UCD.

Prof Frank Barry, professor of international business, Trinity College Dublin.

Prof Gregory Connor, Department of Economics, NUI Maynooth.

Prof John Cotter, professor of finance, Smurfit School of Business, UCD.

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